In the not too distant past many landowners and mineral rights owners choose oil and gas royalty payments over a long period of time as opposed to selling their mineral rights for a single lump sum.

With changes in taxation rates and wild fluctuations in the oil and gas markets, this is no longer the optimal option for a great many people. However, as oil and gas royalty payments can often look like a good deal, understanding how they work and the potential issues with this option will help allow for a more informed decision.

How Royalties are Calculated

In essence, an oil and gas royalty goes into effect once the well is drilled and in production. The royalty payment is provided on a monthly basis and is an amount based on the royalty percentage times the number of acres of the landowner divided by the entire drilling unit acreage.

This amount is determined from gross production, and typically in most leases all production costs, including exploration, drilling and costs after production are covered by the oil and gas company. In some cases, the landowner or mineral rights owner may pay a percentage of some of the costs, but receive a higher percentage of the royalty.

It is critical for a landowner or mineral rights owner to know where the royalty is based, either at the well, which means no costs to the landowner, or in the pipeline or at sale, which will include some of the costs as outlined in the lease.

Why it Matters

The royalty being established based on gross production at the well or at some later date will impact the variability in the royalty payments based on the market conditions and expenses.

As oil and gas royalty payments are considered income, constant variations, especially high royalties for a few months of the year, can push a landowner or mineral rights holder into a much higher tax bracket.

This, in turn, means that there is a higher taxation rate for all of your income. When the oil and gas royalty payments create this issue, you may end up paying a significantly larger amount of taxes, which offsets the increase in income.

It is essential to understand just how oil and gas royalty payments are going to be provided based on the terms of your lease. Take the time to consider the implications of this type of payment to determine if leasing, as opposed to selling the rights, is really in your best interest.